EU faces fiscal discipline at EU summit

By: James Norris | 08 Dec 2011

A Eurozone compromise seems likely at this week’s EU summit, though long-term problems will remain, says Paul Brain, head of fixed income at Newton Investment Management.

Brain says: “Any agreement is likely to be centred upon fiscal discipline and ECB aid.” However, he says: “This is not the long-term answer given the region’s weak growth prospects and struggling banking system.”

Despite the disappointments of the past 18 months and the element of ‘meeting fatigue’, Brain is hopeful that a concrete plan will finally result from the negotiations. “This time around, there does seem to be evidence of the important parties getting closer together. Indeed, the number of times that French President Nicolas Sarkozy and German Chancellor Angela Merkel have met in recent weeks has risen sharply.

“This can possibly be attributed to the sharp rise in French bond yields and the high profile and ‘supposed’ failure German Bund auction a couple of weeks ago – although the German auction process regularly leads to these failures and the Bundesbank mops ups any unwanted bonds – and a sense that the problems are closer to home than France and Germany had previously dared to recognise. Suddenly, a compromise seems viable,” he says.

The most likely agreement is a Eurozone-wide agreement to enshrine fiscal discipline, says Brain. “This would allow the European Central Bank to grease the wheels of economic recovery with greater liquidity injections, and would suit Germany as fiscal discipline would help ease the concerns of its electorate. Furthermore, it would confirm the ECB as the only authority with the unlimited resources to sort out the Eurozone’s problems. A further Eurozone interest rate cut was confirmed today, from 1.25% to 1%, and we now believe that it is now a matter of when, rather than if, the ECB switches on the money printers.

“Such action would most likely prompt a rally for risk assets, although this would probably be fairly short-lived,” he warns. “This is not a long-term answer; commitment to fiscal austerity does not boost the growth or competitiveness of those struggling Eurozone states and their economies will remain highly vulnerable to recession in the meantime. The Eurozone’s struggling banking system will still be with us once the euphoria that will inevitably greet any agreement dies down,” Brain concludes, “and while this is certainly a step in the right direction, we do not believe that it is the answer.”